Semiconductor and Electronics Makers Anticipate a Bounce in Business Spending Next Year

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A longtime investment adage holds that "As goes Intel, so goes the rest of the semiconductor industry."

And as goes the semiconductor industry, so goes the U.S. economy.

These days, microchips are present in virtually every type of product – from coffee makers to cars: If it plugs into the wall or takes batteries, chances are good there's a semiconductor inside.

Given the microchip's ubiquitous nature, the companies that make them – as well as the companies that make the chipmaking equipment – can be viewed as a kind of leading economic indicator. Companies that intend to produce products down the road have to place orders for chips or for equipment now, meaning an uptick in semiconductor-sector business activity today and represent a jump in broader economic growth tomorrow.

"While most chip companies have as yet cited but modest improvement, and forecasts have been held in check, signs of a strong upturn are brewing that will significantly improve upon higher – but still modest – expectations," Rick Whittington, an analyst with JSA Research wrote in a Forbes column earlier this summer. "High proprietary chip content stocks are poised for breakout sales and earnings, probably quickly returning to levels before last summer's plunge."

While consumer spending remains the chief U.S. economic catalyst, accounting for more than two-thirds of gross domestic product (GDP), business spending remains a crucial contributor – especially at a juncture in which consumer confidence has been flayed. Indeed, business spending has stabilized and will return to growth in 2010, semiconductor and other electronics manufacturers believe. In the meantime, they are ramping up production to meet what they believe is a growing consumer demand.

Microchips are used in a broad scope of products: DVD players, automobiles, calculators, coffee makers and televisions, telephones – as well as such stalwarts as personal computers.

Like other economic indicators, electronic-order levels have yet to traverse the economic neutral zone to break into positive territory (marked by the "year-over-year growth" label) but at least the hemorrhaging is subsiding: Sales of semiconductors in North America in the month of July were $3.1 billion, an increase of 5.9% from June, when sales were $2.9 billion, according to the Semiconductor Industry Association (SIA). The continent's 8% year-over-year decline is significantly less than the rest of the world's 18.2%, and was the smallest decline of any major market in the world.

"Sales of consumer products such as netbook PCs and cell phones are supporting the modest recovery that is now under way," said SIA President George Scalise. "Purchases of information technology products by the enterprise sector continue to be tempered by caution and longer replacement cycles. There is evidence of a return to seasonal industry patterns."

Inventories for many chipmakers are at a lower level compared to their average level for the past three years, Purchasing.com reported, citing market research firm iSuppli Corp. But with the holiday season approaching and retail inventory levels already lowered by a weak consumer demand in the first half of 2009, chipmakers are once again ramping up production, according to iSuppli analyst Carlo Cireiello.

Semiconductor inventory levels are now at "appropriate levels, down from previously excessive positions," Ciriello told Purchasing.com. Ciriello forecasted in July that chipmakers would begin building inventories 5.5% in the third quarter and 1% in the fourth.

Semiconductors are used in a broad scope of products: DVD players, automobiles, calculators, coffee makers and televisions, telephones. Money Morning took a look at a few of the bigger players (and related companies) in the industry.

Chipmakers Fuel Business Spending

Intel Corp. (Nasdaq: INTC) reported its first quarterly loss in July, losing $398 million after setting aside $1.45 billion in funds to pay a fine from the European Union, which said Intel used illegal rebates to thwart competitors, Bloomberg News reported. Still, the world's largest chipmaker saw its sales beat analyst estimates and the company late last month boosted its third-quarter revenue forecast to at least $8.8 billion, from an earlier projection of $8.1 billion.

Before Intel raised its guidance, analysts polled by Bloomberg were expecting sales of $8.57 billion. A compilation of analysts' estimates by Thomson Financial Network now has the chipmaker's revenue at $8.93 billion. Intel's revenue in the third quarter of 2008 was $10.2 billion.

The increase in Intel's sales forecast could be attributed to a rebound in PC orders by consumers in Asia, and Edward Jones & Co. analyst William Kreher says the higher guidance bodes well for the technology industry because Intel is a barometer for spending.

"Consumers are driving the strength and the relative strength in PCs," Kreher told Bloomberg. "We do have an expectation that 2010 will bring renewed demand from the corporate sector as well."

"Demand for a lot of consumer devices seems to be picking up from six months ago, both in the U.S. and non-U.S., particularly non-U.S.," Marvell Chief Financial Officer Clyde Hosein said in an interview with Reuters. "That has picked up substantially since the April time frame and continues to improve or maybe accelerate."

Investing to Build a Better Chip

If the health of microchip firms is a leading indicator of the outlook for the overall economy, then the outlook for semiconductor-equipment manufacturers is a harbinger of what's to come for chipmaking sector.

The reason is simple: As chips become more powerful, they also become more complex – meaning the chipmaking process becomes increasingly demanding and deft. So before semiconductor firms can ramp up in a big way, they need to invest in the latest and greatest equipment.

That's where the equipment stocks come into play.

Capital expenditures – known as "capex" in Wall Street parlance – is a closely watched statistic. Chipmaking firms invest in new gear to expand capacity, to move to the newest technology, or both.

Because of the global financial crisis, so-called "capacity utilization" – the number of chips being turned out as a percentage of what those factories are capable of turning out – plunged to 55.6% in the first quarter of 2009 from 89.7% during the same period a year ago, the SIA reported.

And with more than 40% of the industry's "fab" capacity sitting fallow, new plants aren't being built – especially since they cost about $3 billion each, TheStreet.com reported. Several of the equipment players have filed for bankruptcy as a result.

Coming into this year, only three semiconductor firms planned to invest more than $1 billion in new equipment: Intel, Taiwan Semiconductor Manufacturing Co. Ltd. (NYSE ADR: TSM) and Samsung Electronics Co. Ltd.

That's down from eight companies in 2008 and 16 in 2007.

But the tide appears to be turning – and investments will ramp up as the worldwide economy improves. Already, United Microelectronics Corp. (NYSE ADR: UMC) announced it is boosting its outlays for new equipment to $500 million from the $400 million it planned earlier in the year. Chartered Semiconductor will increase capex to $500 million from the $400 million announced earlier this year. That will be an increase from the $349 million the company spent in 2008.

Chartered Semiconductor Manufacturing Co. Ltd. (Nasdaq ADR: CHRT) is boosting its outlay from the $375 million planned early in the year to $500 million now, according to TheStreet.com. And Toshiba Corp will spend $900 million – down from $3.2 billion last year, but still more than many analysts initially expected.

Additionally, U.S.-based equipment firms will benefit from a weaker U.S. dollar, which makes American products cheaper in foreign-currency terms.

One such U.S. firm is longtime industry leader Lam Research Inc. (Nasdaq: LRCX), which is experiencing an improvement in its business despite a loss in its recently reported fourth-quarter results. Those results included better-than-expected revenue.

During the fourth quarter, which ended June 30, the company said "business conditions improved … contributing to Lam's ability to show improved financial results for the quarter. Shipments and revenues increased as a result of customer investments to add [leading-edge capacity] in both foundry and memory."

And while business continues to improve, Lam said it hasn't lost sight of the need to carefully manage cash and to invest considerable care in choosing where to make next-generation strategic investments.

Lam's shares have surged nearly 42% so far this year, although they remain 21% below their 52-week high of $37.96. The shares closed yesterday at $30.16, up 5 cents each on a day the major U.S. stock indices were down for a fourth-straight day.

Older PCs Set Stage For Hardware Refresh

Dell Inc. (Nasdaq: DELL) Chairman and Chief Executive Officer Michael Dell is on a mission to save his company $4 billion a year.

The company outsourced 40% of its manufacturing as of its second quarter, helping it achieve an 18.7% gross margin that exceeded analysts' expectations. Dell's profit of 28 cents a share also beat Wall Street's estimate of 28 cents.

CEO Dell sees Microsoft Corp.'s (Nasdaq: MSFT) October 22 release of Windows 7, as well as faster processors from Intel, as the ignition for PC and server purchases next year.

Dell remains confident that a majority of its business customers are deferring purchases and will accelerate IT spending to take advantage of technology improvements like Windows 7 and Microsoft's Office 2010, according to Chief Financial Officer Brian Gladden.

"This acceleration remains predicated on an improving economy and related improvements in customer profits and government tax receipts," Gladden said.

For Hewlett-Packard Co. (NYSE: HPQ), its earnings of 91 cents a share narrowly beat Wall Street estimates of 90 cents, and Chief Executive Officer Mark Hurd sees stabilization, but was reluctant to say the bottom has been reached.

"Business is stabilizing, and we are confident that HP will be an early beneficiary of an economic turnaround and will continue to outperform when conditions improve," Hurd said.

Both H-P and Dell have already credited consumers in Asia for a rebound in orders in PCs, Bloomberg reported.

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[…] most chip stocks, Intel is an economic leading indicator of sorts – a fact that bodes well for the U.S. recovery. Intel said demand actually strengthened as the quarter moved along. This is the precursor of a […]

[…] sales of computers in the United States and Asian markets like China. Business technology sales aren't expected to bounce back until next year, but Intel Chief Executive Officer and President Paul Otellini told analysts in a conference call […]

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